Which of the following statements is CORRECTσ
A) other things held constant, if investors suddenly become convinced that there will be deflation in the economy, then the required returns on all stocks should increase.
B) if a company's beta were cut in half, then its required rate of return would also be halved.
C) if the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rates of return on stocks with betas less than 1.0 will decline while returns on stocks with betas above 1.0 will increase.
D) if the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rate of return on an average stock will remain unchanged, but required returns on stocks with betas less than 1.0 will rise.
E) if a company's beta doubles, then its required rate of return will also double.

Question

Quizplus · Accepted Answer

According to the Capital Asset Pricing Model (CAPM), the required rate of return on an asset equals the risk-free rate plus a premium for bearing market risk (market risk premium) multiplied by the asset's beta. Therefore, if the risk-free rate increases while the market risk premium declines by the same amount, the required rate of return on an average stock will remain unchanged as there will be an offsetting effect. However, stocks with lower betas will experience an increase in required returns while stocks with higher betas will experience a decrease in required returns. Therefore, statement D is the correct option.

Which of the Following Statements Is CORRECTσ